Smiles won’t get CEOs far in China

Chinese President Xi Jinping, left, talks with Facebook Chief Executive Mark Zuckerberg, right, during a gathering of CEOs and other executives at Microsoft's main campus September 23, 2015 in Redmond, Washington. Ted S. Warren-Pool/Getty Images

American CEOs mistakenly believe business relationships can open all the doors they need in China.

These relationships are referred to by the Chinese word guanxi.

Guanxi can't halt China's growing intrusions, under the guise of security, into the supply chains that have been such a crucial part of the U.S.-China trade relationship.

President Xi Jinping has already shown a personal willingness to pressure executives to relay his trade intentions to Washington.

As far as Elon Musk is concerned, his trip to China this month went just great. He arrived back in the United States after a meet-and-greet with Wang Qishan, China's newly appointed U.S. interlocutor. The Tesla, Inc. CEO reflected admiringly on Wang's knowledge of culture and philosophy, and he claimed "the world has never seen human energy & vigor at such scale" as in China.

Musk's enthusiasm represents a common reaction from CEOs, from Apple's Tim Cook to Facebook's Mark Zuckerberg, after hobnobbing with top-level Chinese leaders. Entrepreneurs almost always walk away from showy, flattering meetings convinced that the Chinese side is sympathetic to their needs and that they can play a pivotal role in the complex relations between Washington and Beijing.

But they're badly mistaken, and the fundamentals of foreign businesses in China are under serious political threat from a government obsessed with its own ideas of national security.

CEOs are given to falling for these carefully managed meetings, in part from ego and in part because of their persistent belief that these business relationships—inevitably referred to by the Chinese word guanxi—can open all the doors they need in China. But while guanxi can grease the wheels of getting meetings or getting attention to deals, it can't halt China's growing intrusions, under the guise of security, into the supply chains that have been such a crucial part of the U.S.-China trade relationship.

Multinationals' day-to-day operations in China face unhappy prospects. In Bain & Company's 2018 China Business Climate Survey, conducted with the American Chamber of Commerce in China, 75 percent of respondents felt that foreign companies are increasingly unwelcome there, with regulation remaining a major concern. Oversight over foreign enterprises is unlikely to lighten as China pursues "indigenous innovation" in the lucrative sectors identified in its Made in China 2025 plans. Forced technology transfers or unethical data theft by individual staff members poached by Chinese firms pose real risks to multinational businesses, as does the growing presence of the Chinese security state.

The frustration of multinationals is starting to show. "What is your situation in China now?" Kara Swisher of Recode asked Mark Zuckerberg this month. "I mean, we're blocked," he replied bluntly. However, Zuckerberg's China ambitions haven't been fully dashed, as he added, "It's hard to have a mission of wanting to bring the whole world closer together and leave out the biggest country."

Facebook CEO Mark Zuckerberg and the overseas representatives of the China Development Forum applaud as Chinese Premier Li Keqiang arrives for a meeting at the Great Hall of the People in Beijing on March 21, 2016.Kenzaburo Fukuhara - Pool/Getty Images

This "mission" is typical of a romantic vision that American firms have nursed since 19th-century merchants and missionaries dreamt of opening the Chinese market. Yet content platforms such as Facebook remain censored behind a firewall that is thickening every month, and money pours into incubators to replace technologies.

Existing obstacles are being maintained, but new ones are also being put in place. Security has become the standard justification for the array of new laws and regulation enforcements targeting multinational firms. Many of the private-sector activities being controlled don't fall under traditional concepts of national security, but for regulators, "security concerns" can describe problems ranging from how a website classifies Taiwan to the degree of market access a technology firm possesses. Foreign businesses are increasingly at risk from political events and controversial security developments.

Take the South Korean-Japanese grocery conglomerate Lotte, which fell victim to a Chinese quarrel with Seoul over the deployment of a U.S. missile system. Consumer boycotts encouraged by stories run by state media such as Xinhua resulted in serious sales drops that led to Lotte's withdrawal from the Chinese market last year.

While U.S. suppliers remain a key part of Chinese business for now, President Xi Jinping has already shown a personal willingness to pressure executives to relay his trade intentions to Washington.

China's President Xi Jinping inspects a guard of honour as he arrives for a meeting with South African President Cyril Ramaphosa at the Union Buildings in Pretoria, South Africa, July 24, 2018. Reuters

Those intentions put Xi's political vision at the heart of business policy. As Citizen Lab researcher Lotus Ruan argues, emerging Chinese policy language interprets the idea of security broadly and includes actions related to "the control and censoring of public debate in ways that may affect the power or standing of the ruling Chinese Communist Party." Xi's government and personnel reshuffles are an important indicator of just how closely he wants the industrial sector to mirror his personal vision.

Longtime Xi loyalist Liu He was recently promoted to vice premier; Liu now leads trade negotiations with the United States, and he also helped formally integrate "Xi Jinping thought" into China's economic plans. As Xi's consolidation of power continues, China's domestic policy world is signaling that Made in China 2025 is about what Xi wants, with little wriggle room for any deviation.

Further down the political food chain, think tank and private-sector interlocutors frustrate foreign scholars by refusing to deviate from rote party-line responses that allow no room for the interests of foreign firms.

In summer 2016, Scott Kennedy, the deputy director of the Center for Strategic International Studies' China program, attended an innovation dialogue affiliated with the then-prominent U.S.-China Strategic & Economic Dialogue.

After a tense exchange, Kennedy characterized his Chinese dialogue counterparts as "unapologetically" offering defenses of market protections for electric vehicle batteries, a critical industrial sector for China. They insisted that if foreign firms wanted in, the cost was investing in China with domestic joint venture partners. There has been no indication that China is willing to yield on opening markets to sectors it deems strategically important or that it believes could be a potential security risk.

Ambitious foreign corporations should look to the experiences of Chinese firms, which act as canaries in the coal mine. The United Front Work Department, a key party body mostly known for its work funding influence operations outside of China, also works domestically to manage private-sector behavior. The United Front's commercial oversight has traditionally provided incentives, technical support, and networking opportunities for Chinese entrepreneurs. These umbrella organizations have been key to how Chinese industries network, receive resources, and speed through regulatory processes. Growing a supply chain or larger corporation without connections to United Front organizations is impossible.

So far, China's carrot-and-stick industrial drive is earning the government significant buy-in from the private sector, well beyond simple compliance with its broadening security law. Ruan posits that "many of [China's private sector companies]—including the industry leaders—are building their business model predominantly around the needs of the state." In turn, it is likely that China's trade and industrial policies, from data rules to technology transfers, will be built to benefit the domestic firms that it intends to boost.

The message sent to domestic firms has been clear: Cooperate, and your organization can prosper. Operate outside of the government's standards, and you'll find operations more difficult—as Wang Xiaochuan, the CEO of Sogou, a Chinese search engine, has described. There's no escaping the new political agenda in the Chinese market.

When China sees business as politics, business leaders need to start approaching their meetings with the same mindset and with a realistic understanding of what's possible. It's never savvy to be rude to your hosts, but effusive comments of the kind offered by Musk will be read by China's leadership as a sign that they can act as they like toward multinational firms.

Taking precautions against potential changes in the treatment of foreign firms is an essential operational reality for executives. The Chinese government may cut the ribbon on a Tesla factory one day and send in inspectors for strict crackdowns the next. Shorter leashes and less leeway for foreign firms are on the agenda, and America's corporate soft power in China is set to come up against plans and institutions determined to erode it.